What is a gift?
You want to help your child with the purchase of their new home but you are worried you will have to pay a ‘gift tax.’ What exactly is this tax and how does it work. Well, to start, the IRS defines a gift as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.” In other words, if you give someone something of value and don’t receive an equal value in return, you’ve given them a gift.
How are gifts taxed?
Gifts that you or your child receives are not considered income, and don’t get reported on your tax return. That being said, you can’t simply dodge taxes by calling your income a gift. If, for example, you receive a “gift” in return for services rendered, it’s not a gift.
So what’s all this talk about gift taxes? The gift tax actually applies to the donor, not the recipient. The whole point of this tax is to prevent individuals from transfer their estate to others before their death, thereby avoiding the estate tax.
Exclusions from the gift tax
There is an annual gift tax exclusion that currently stands at $13k/recipient. In other words, you’re allowed to give away up to $13k per recipient per year, to as many recipients as you wish, without any tax implications. This limit is effectively doubled for married couples, who can jointly give gifts up to $26k/year total to a single recipient.
As importantly, there is also a second, $1M lifetime limit of gifts in excess of the $13k annual limit before the gift tax is triggered. If you exceed this limit, then you’ll either have to pay the gift taxes that year, or use up a portion of this lifetime limit that would otherwise be used to offset the estate tax upon your death.
Gift tax returns and the gift tax rate
If you exceed the annual exclusion of $13k/recipient, you’ll have to file a gift tax return. But remember, you still won’t have to pay the gift tax until you reach the $1M lifetime limit. What happens once you exceed your $1M lifetime limit? How much will you owe? At that point, the gift tax rate is, essentially, the estate tax rate and the amount owed will depend upon the estate tax rates in force at that time.